MACY'S INC M
March 14, 2014 - 4:47pm EST by
cnm3d
2014 2015
Price: 58.00 EPS $4.00 $4.50
Shares Out. (in M): 368 P/E 14.0x 13.0x
Market Cap (in $M): 21,585 P/FCF 13.0x 12.0x
Net Debt (in $M): 5,000 EBIT 2,766 2,950
TEV ($): 26,000 TEV/EBIT 9.4x 8.8x

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  • Retail
  • Share Repurchase

Description

M Write up

March 14, 2014

 

Recommendation: Long

 

Current Price: $58

Target Price: $74

Worst Case Target: $50 (and I’d be a big buyer there.)

52 Week Range: $41.58-$58.94

Average Liquidity:  4.4MM shares or $255MM per day

 

Trader Talk: Quality business at a reasonable multiple with underappreciated competitive advantages

 

 

If you want an exciting, imaginative special situations play with 3x upside in the next six months, this is not it.

If you want a beaten down, hated name with a brilliant contrarian call, you’re going to want to pass on this.

If you love exciting GARP stocks with big TAMs, this will bore you to tears.

 

But if you want a reasonably priced stock, returning cash to shareholders, with strong competitive advantages, that will continue to compound and has very little downside over a period of time, you might like Macy’s.

 

Thesis

 

Macy’s Inc., which owns Macy’s and Bloomingdale’s,  is a high quality department store operator that continues to execute and is uniquely positioned in US retail yet still trades at a below market multiple. Key to understanding Macy’s competitive advantage is their significantly higher revenues compared to other department stores. This scale advantage gives Macy’s significant leverage over their vendors, resulting in gross margin consistency and operating margin expansion. Further, their scale, combined with their strong consumer image, gives Macy’s access to key brands that competitors (like KSS) don’t, such as Kors and Ralph Lauren. Macy’s also is significantly ahead of the competition in online retail and have already consolidated their store base.

 

Valuation

  • Target Case: If comp growth stays at 3-4% through 2014 and into 2015 and operating margins improve 30bps to 10.4%, I believe M can earn $5.25. Continued execution by M should drive the market to appreciate Macy’s unique position, resulting in M gaining an extra multiple point. Over the next twelve months, I value M at 14x my 2015 estimates, or $74 per share.
    • It is important to note that a significant percentage of M’s EPS growth is attributable to their buyback. I forecast operating profits to grow ~6% vs. EPS growth of 16%.
  • Downside Case: If Macy’s were to miss quarterly comps/margins (due to weather, rate shock, etc.), I believe M could trade as low as 11x 2014 estimates, which implies $50.
    • I would be an aggressive buyer of M’s stock should it be penalized on short term execution issues.
    • My downside scenario does not include a recession or more secular challenges to Macy’s business, the latter of which I explain in the write up.
      • You’re on your own on the macro, though I’m bullish over a medium to long term period.
  • Note: I don’t provide an operating model here. Partially because VIC won’t format it right, but mainly because I am making very simple assumptions about sales and margins and Macy’s has plenty of sell side coverage.
    • The key to my divergent view is a better understanding of Macy’s competitive advantages, not a better modeling of their earnings.

 

Risks

  • Macro slowdown
  • Macy’s execution issues
    • During 2012 and 2013, M posted underwhelming numbers/guidance a few times. In each case, it was a great opportunity to buy.
  • Souring relationships with vendors
    • M enjoys strong relationships with vendors, which are a key to Macy’s success
    • If Macy’s were to lose it cache and ability to attract high quality brands, the M story is at risk

Catalysts                                                                                                                                                                  

  • Quarterly earnings beats
    • M has met or exceeded earnings estimates in 7 of the last 8 quarters
  • Better spring weather
    • Retail in general has been weak in Q1 (though not M), so a better spring season could accelerate M’s SSS and improve M shares
  • Potentially increased buyback
    • While M returns most of its FCF to shareholders via buybacks and dividends, M is modestly levered at ~2.2x adjusted debt to EBITDAR
    • If M’s stock were to come under pressure for an extended period of time (say two quarters), the board has room to increase the buyback
  • Increasing consumer confidence
    • Home prices are going up, employment is increasing, and consumer confidence is increasing

 

 

Poster Note: M is amply covered by the sellside, so I will not focus on near term numbers besides to comment “they look reasonable and I don’t really care anyways.” The remainder of this write up will focus on the structural advantages M has that are unlikely to fade away anytime soon.

 

 

The Current State of Retail vs. M

  • In my opinion, beyond general macro worries, the biggest issues facing retailers are the growth of online retail, the emergence of a “value mindset” among consumers following the Great Recession, and, particular to apparel players, the explosion of “fast fashion” and the general improvements in apparel supply chains affecting the traditional operating structure of most retailers
  • M is well positioned to handle all three
    • M is a leader in online and already downsized their store base following their merger of Federated and May in 2005
    • M has a lean, streamlined operation which combined with their leverage over vendors and access to the hottest brands ensures adequate margins
    • Macys/Bloomingdales aren’t really impacted by fast fashion as they  are department stores
      • Actually, as basically an acquirer and reseller of goods, the increase in supply chain speed is a benefit that results in more “just in time” inventory and fewer markdowns

 

Scale vs. Vendors

  • Macy’s is by far the largest US retailer of medium to high end apparel and accessories
    • M has 2x the sales of Kohls, 6x Dillards, 9x Saks, 2.5x Nordstrom, etc.
  • No one else is close to capable of placing orders on the scale of Macy’s and many brands, particularly those selling primarily wholesale with few or no direct stores, have few options but to sell to Macy’s
    • This puts Macy’s in a considerably advantaged position versus their vendors, both from a purchasing price perspective and from an access to quality brands perspective
    • M is just vastly more important to most of its vendors than any single vendor is to Macy’s
      • Macy’s is 23% of PVH’s business and 13% of RL’s (25% of their wholesale), and those are among the largest wholesale apparel companies in the world
      • Not one of Macy’s suppliers is more than 5% of Macy’s costs of goods
  • Macy’s purchasing price advantage can be seen in their gross margins
    • While VIC will not be able to properly format my table, a simple Bloomberg search will show that M’s gross margins exhibit remarkable consistency, rarely oscillating more than 20 bps y/y
    • Compare that to say JWN or KSS, who frequently see gross margins up or down 100 to 200 points, and you can appreciate the leverage Macy’s has to demand vendor allowances, advertising allowances, returns, etc.
  • Macy’s size also enables it to access the best brands
    • While a little more qualitative, M has access to virtually any brand it wants below certain luxury names
      • And even most luxury brands sell to Bloomies…
      • Note: There are some exceptions, like Uggs, but they are few and far between
    • Part of this is Macy’s successful merchandising, but part of it is just Macy’s pure scale
    • There’s just no one else capable of cutting these checks
  • To put it bluntly, when you buy a billion dollars’ worth of Ralph Lauren and two billion dollars’ worth of Calvin/Tommy, you can pretty much get whatever you want

 

Access to Key Brands

  • While I touch upon it above, Macy’s access to brands should be elaborated upon as it drives their sales and competitive advantage versus other department stores
  • There is a symbiotic relationship between Macy’s and its vendors
    • Brands trust Macy’s as a quality merchant who will protect their image
      • Fashion is all about image…
      • Wal-Mart might be able to buy a TON of Kors bags, but the image of Kors bags hanging in “Action Alley” doesn’t exactly mesh with Kors’s “jet set lifestyle”
    • In return, Macy’s gets access to the hottest selling brands, which drive traffic and additional sales
      • The biggest challenge in retail is getting the customers in the door in the first place
  • This access to key brands has resulted in Macy’s consistently outcomping the competition over the last few years
  • It’s also important to note that as M continues to grow and key competitors such as KSS and JCP continue to flail, Macy’s competitive advantage only gets bigger

 

Online Sales/Omnichannel

  • Macy’s was an early innovator in online apparel sales
  • While most department/big box stores were trying to protect margin in the Great Recession, Macy’s was willing to invest in the distribution centers and IT systems required to drive online sales
    • So while others, such as KSS, are lagging the market and seeing margin degradation from an inability to leverage upfront costs, M is seeing operating margin expansion
  • It’s important to understand that e-commerce is easier said than done
    • Things like in-store pick up, shipping from store, return to store, etc.
  • Macy’s has practice, expertise, and leadership in the space, resulting again in higher SSS than the competition

 

Store Base

  • My final brief point is that Macy’s has already gone through a very large store base consolidation following the Federated/May’s merger in 2005
    • There 790 Macy’s stores and 50 Bloomingdale’s full-line and outlets
    • Compare that to 800 Sear’s (who shops at Sear’s?), 1200 Kohl’s, 1100 jcpenny’s…
  • Given Macy’s much larger sales with an equal or smaller store base, Macy’s has much higher sales per square foot
    • This better enables Macy’s to lever its fixed costs as we increasingly head towards an “online world”
  • In the next few years, it is likely that many department stores will be forced to rationalize their store base
    • Macy’s has already done that
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts                                                                                                                                                                  

  • Quarterly earnings beats
    • M has met or exceeded earnings estimates in 7 of the last 8 quarters
  • Better spring weather
    • Retail in general has been weak in Q1 (though not M), so a better spring season could accelerate M’s SSS and improve M shares
  • Potentially increased buyback
    • While M returns most of its FCF to shareholders via buybacks and dividends, M is modestly levered at ~2.2x adjusted debt to EBITDAR
    • If M’s stock were to come under pressure for an extended period of time (say two quarters), the board has room to increase the buyback
  • Increasing consumer confidence
    • Home prices are going up, employment is increasing, and consumer confidence is increasing 
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